CHAPTER 2Financial Statements & Cash Flow Multiple Choice Questions:I. DEFINITIONSBALANCE SHEETb 1. The financial statement showing a firm’s accounting value on a particular date is the:a. income statement.b. balance sheet.c. statement of cash flows.d. tax reconciliation statement.e. shareholders’ equity sheet.Difficulty level: EasyCURRENT ASSETSc 2. A current asset is:a. an item currently owned by the firm.b. an item that the firm expects to own within the next year.c. an item currently owned by the firm that will convert to cash within the next 12 months.d. the amount of cash on hand the firm currently shows on its balance sheet.e. the market value of all items currently owned by the firm.Difficulty level: EasyLONG-TERM DEBTb 3. The long-term debts of a firm are liabilities:a. that come due within the next 12 months.b. that do not come due for at least 12 months.c. owed to the firm’s suppliers.d. owed to the firm’s shareholders.e. the firm expects to incur within the next 12 months.Difficulty level: EasyNET WORKING CAPITALe 4. Net working capital is defined as:a. total liabilities minus shareholders’ equity.b. current liabilities minus shareholders’ equity.c. fixed assets minus long-term liabilities.d. total assets minus total liabilities.e. current assets minus current liabilities.Difficulty level: EasyLIQUID ASSETSd 5. A(n) ____ asset is one which can be quickly converted into cash without significantloss in value.a. currentb. fixedc. intangibled. liquide. long-termDifficulty level: EasyINCOME STATEMENTa 6. The financial statement summarizing a firm’s performance over a period of time is the:a. income statement.b. balance sheet.c. statement of cash flows.d. tax reconciliation statement.e. shareholders’ equity sheet.Difficulty level: EasyNONCASH ITEMSd 7. Noncash items refer to:a. the credit sales of a firm.b. the accounts payable of a firm.c. the costs incurred for the purchase of intangible fixed assets.d. expenses charged against revenues that do not directly affect cash flow.e. all accounts on the balance sheet other than cash on hand.Difficulty level: EasyMARGINAL TAX RATESe 8. Your _____ tax rate is the amount of tax payable on the next taxable dollar you earn.a. deductibleb. residualc. totald. averagee. marginalDifficulty level: EasyAVERAGE TAX RATESd 9. Your _____ tax rate measures the total taxes you pay divided by your taxable income.a. deductibleb. residualc. totald. averagee. marginalDifficulty level: EasyCASH FLOW FROM OPERATING ACTIVITIESa 10. _____ refers to the cash flow that results from the firm’s ongoing, normal businessactivities.a. Cash flow from operating activitiesb. Capital spendingc. Net working capitald. Cash flow from assetse. Cash flow to creditorsDifficulty level: MediumCASH FLOW FROM INVESTINGb 11. _____ refers to the changes in net capital assets.a. Operating cash flowb. Cash flow from investingc. Net working capitald. Cash flow from assetse. Cash flow to creditorsDifficulty level: MediumNET WORKING CAPITALc 12. _____ refers to the difference between a firm’s current assets and its current liabilities.a. Operating cash flowb. Capital spendingc. Net working capitald. Cash flow from assetse. Cash flow to creditorsDifficulty level: EasyCASH FLOW OF OPERATIONSd 13. _____ refers to the net total cash flow of the firm available for distribution to itscreditors and stockholders.a. Operating cash flowb. Capital spendingc. Net working capitald. Cash flow from operationse. Cash flow to creditorsCASH FLOW TO CREDITORSe 14. _____ refers to the firm’s interest payments less any net new borrowing.a. Operating cash flowb. Capital spendingc. Net working capitald. Cash flow from shareholderse. Cash flow to creditorsCASH FLOW TO STOCKHOLDERSe 15. _____ refers to the firm’s dividend payments less any net new equity raised.a. Operating cash flowb. Capital spendingc. Net working capitald. Cash flow from creditorse. Cash flow to stockholdersEARNINGS PER SHAREa 16. Earnings per share is equal to:a. net income divided by the total number of shares outstanding.b. net income divided by the par value of the common stock.c. gross income multiplied by the par value of the common stock.d. operating income divided by the par value of the common stock.e. net income divided by total shareholders’ equity.DIVIDENDS PER SHAREb 17. Dividends per share is equal to dividends paid:a. divided by the par value of common stock.b. divided by the total number of shares outstanding.c. divided by total shareholders’ equity.d. multiplied by the par value of the common stock.e. multiplied by the total number of shares outstanding.II. CONCEPTSCURRENT ASSETSa 18. Which of the following are included in current assets?I. equipmentII. inventoryIII. accounts payableIV. casha. II and IV onlyb. I and III onlyc. I, II, and IV onlyd. III and IV onlye. II, III, and IV onlyCURRENT LIABILITIESb 19. Which of the following are included in current liabilities?I. note payable to a supplier in eighteen monthsII. debt payable to a mortgage company in nine monthsIII. accounts payable to suppliersIV. loan payable to the bank in fourteen monthsa. I and III onlyb. II and III onlyc. III and IV onlyd. II, III, and IV onlye. I, II, and III onlyBALANCE SHEETd 20. An increase in total assets:a.means that net working capital is also increasing.b.requires an investment in fixed assets.c.means that shareholders’ equity must also increase.d.must be offset by an equal increase in liabilities and shareholders’ equity.e.can only occur when a firm has positive net income.LIQUIDITYc 21. Which one of the following accounts is generally the most liquid?a. inventoryb.buildingc.accounts receivabled.equipmente.patentLIQUIDITYe 22. Which one of the following statements concerning liquidity is correct?a.If you sold an asset today, it is a liquid asset.b.If you can sell an asset next year at a price equal to its actual value, the asset is highlyliquid.c.Trademarks and patents are highly liquid.d.The less liquidity a firm has, the lower the probability the firm will encounter financialdifficulties.e.Balance sheet accounts are listed in order of decreasing liquidity.LIQUIDITYd 23. Liquidity is:a. a measure of the use of debt in a firm’s capital structure.b.equal to current assets minus current liabilities.c.equal to the market value of a firm’s total assets minus its current liabilities.d.valuable to a firm even though liquid assets tend to be less profitable to own.e.generally associated with intangible assets.SHAREHOLDERS’ EQUITYd 24. Which of the following accounts are included in shareholders’ equity?I. interest paidII. retained earningsIII. capital surplusIV. long-term debta. I and II onlyb. II and IV onlyc. I and IV onlyd. II and III onlye. I and III onlyBOOK VALUEb 25. Book value:a. is equivalent to market value for firms with fixed assets.b.is based on historical cost.c.generally tends to exceed market value when fixed assets are included.d.is more of a financial than an accounting valuation.e.is adjusted to market value whenever the market value exceeds the stated book value. MARKET VALUEa 26. When making financial decisions related to assets, you should:a.always consider market values.b.place more emphasis on book values than on market values.c.rely primarily on the value of assets as shown on the balance sheet.d.place primary emphasis on historical costs.e.only consider market values if they are less than book values.INCOME STATEMENTd 27. As seen on an income statement:a.interest is deducted from income and increases the total taxes incurred.b.the tax rate is applied to the earnings before interest and taxes when the firm has bothdepreciation and interest expenses.c.depreciation is shown as an expense but does not affect the taxes payable.d.depreciation reduces both the pretax income and the net income.e.interest expense is added to earnings before interest and taxes to get pretax income. EARNINGS PER SHAREa 28. The earnings per share will:a. increase as net income increases.b.increase as the number of shares outstanding increase.c.decrease as the total revenue of the firm increases.d.increase as the tax rate increases.e.decrease as the costs decrease.DIVIDENDS PER SHAREe 29. Dividends per share:a. increase as the net income increases as long as the number of shares outstandingremains constant.b.decrease as the number of shares outstanding decrease, all else constant.c.are inversely related to the earnings per share.d.are based upon the dividend requirements established by Generally AcceptedAccounting Procedures.e.are equal to the amount of net income distributed to shareholders divided by thenumber of shares outstanding.REALIZATION PRINCIPLEb 30. According to Generally Accepted Accounting Principles,a.income is recorded based on the matching principle.b.income is recorded based on the realization principle.c.costs are recorded based on the liquidity principle. income is recorded based on the realization principle.e.depreciation is recorded as it affects the cash flows of a firm.MATCHING PRINCIPLEc 31. According to Generally Accepted Accounting Principles, costs are:a. recorded as incurred.b. recorded when paid.c. matched with revenues.d. matched with production levels.e. expensed as management desires.NONCASH ITEMSa 32. Depreciation:a. is a noncash expense that is recorded on the income statement.b.increases the net fixed assets as shown on the balance sheet.c.reduces both the net fixed assets and the costs of a firm.d.is a non-cash expense which increases the net operating income.e.decreases net fixed assets, net income, and operating cash flows.MARGINAL TAX RATEc 33. When you are making a financial decision, the most relevant tax rate is the _____ rate.a. averageb.fixedc.marginald.totale.variableOPERATING CASH FLOWa 34. An increase in which one of the following will cause the operating cash flow toincrease?a. depreciationb.change in net working capital working capitald.taxese.costsCHANGE IN NET WORKING CAPITALe 35. A firm starts its year with a positive net working capital. During the year, the firmacquires more short-term debt than it does short-term assets. This means that:a. the ending net working capital will be negative.b. both accounts receivable and inventory decreased during the year.c. the beginning current assets were less than the beginning current liabilities.d. accounts payable increased and inventory decreased during the year.e. the ending net working capital can be positive, negative, or equal to zero.CASH FLOW TO CREDITORSc 36. The cash flow to creditors includes the cash:a.received by the firm when payments are paid to suppliers.b.outflow of the firm when new debt is acquired.c. outflow when interest is paid on outstanding debt.d. inflow when accounts payable decreases.e. received when long-term debt is paid off.CASH FLOW TO STOCKHOLDERSa 37. Cash flow to stockholders must be positive when:a.the dividends paid exceed the net new equity raised.b.the net sale of common stock exceeds the amount of dividends paid.c.no income is distributed but new shares of stock are sold.d.both the cash flow to assets and the cash flow to creditors are negative.e.both the cash flow to assets and the cash flow to creditors are positive. BALANCE SHEETb 38. Which equality is the basis for the balance sheet?a. Fixed Assets = Stockholder's Equity + Current Assetsb. Assets = Liabilities + Stockholder's Equityc. Assets = Current Long-Term Debt + Retained Earningsd. Fixed Assets = Liabilities + Stockholder's Equitye. None of the above.BALANCE SHEETa 39. Assets are listed on the balance sheet in order of:a. decreasing liquidity.b. decreasing size.c. increasing size.d. relative life.e. None of the above.DEBTe 40. Debt is a contractual obligation that:a. requires the payout of residual flows to the holders of these instruments.b. requires a repayment of a stated amount and interest over the period.c. allows the bondholders to sue the firm if it defaults.d. Both A and B.e. Both B and C.CARRYING VALUEa 41. The carrying value or book value of assets:a. is determined under GAAP and is based on the cost of the asset.b. represents the true market value according to GAAP.c. is always the best measure of the company's value to an investor.d. is always higher than the replacement cost of the assets.e. None of the above.GAAPd 42. Under GAAP, the value of all the firm's assets are reported at:a. market value.b. liquidation value.c. intrinsic value.d. cost.e. None of the above.INCOME STATEMENTe 43. Which of the following statements concerning the income statement is true?a. It measures performance over a specific period of time.b. It determines after-tax income of the firm.c. It includes deferred taxes.d. It treats interest as an expense.e. All of the above.GAAP INCOME RECOGNITIONb 44. According generally accepted accounting principles (GAAP), revenue is recognized asincome when:a. a contract is signed to perform a service or deliver a good.b. the transaction is complete and the goods or services are delivered.c. payment is requested.d. income taxes are paid.e. All of the above.OPERATING CASH FLOWb 45. Which of the following is not included in the computation of operating cash flow?a. Earnings before interest and taxesb. Interest paidc. Depreciationd. Current taxese. All of the above are included.NET CAPITAL SPENDINGb 46. Net capital spending is equal to:a. net additions to net working capital.b. the net change in fixed assets.c. net income plus depreciation.d. total cash flow to stockholders less interest and dividends paid.e. the change in total assets.CASH FLOW TO STOCKHOLDERSd 47. Cash flow to stockholders is defined as:a. interest payments.b. repurchases of equity less cash dividends paid plus new equity sold.c. cash flow from financing less cash flow to creditors.d. cash dividends plus repurchases of equity minus new equity financing.e. None of the above.FREE CASH FLOWd 48. Free cash flow is:a. without cost to the firm.b. net income plus taxes.c. an increase in net working capital.d. cash flow in excess of that required to fund profitable capital projects.e. None of the above.CASH FLOWd 49. The cash flow of the firm must be equal to:a. cash flow to equity minus cash flow to debtholders.b. cash flow to debtholders minus cash flow to equity.c. cash flow to governments plus cash flow to equity.d. cash flow to equity plus cash flow to debtholders.e. None of the above.STATEMENT OF CASH FLOWSa 50. Which of the following are all components of the statement of cash flows?a. Cash flow from operating activities, cash flow from investing activities, and cash flowfrom financing activitiesb. Cash flow from operating activities, cash flow from investing activities, and cashflowfrom divesting activitiesc. Cash flow from internal activities, cash flow from external activities, and cash flowfrom financing activitiesd. Cash flow from brokering activities, cash flow from profitable activities, and cash flowfrom non-profitable activitiese. None of the above.III. PROBLEMSCURRENT ASSETSb 51. A firm has $300 in inventory, $600 in fixed assets, $200 in accounts receivables, $100in accounts payable, and $50 in cash. What is the amount of the current assets?a. $500b. $550c. $600d. $1,150e. $1,200NET WORKING CAPITALb 52. The total assets are $900, the fixed assets are $600, long-term debt is $500, and short-term debt is $200. What is the amount of net working capital?a. $0b. $100c. $200d. $300e. $400LIQUIDITYd 53. Brad’s Company has equipme nt with a book value of $500 that could be sold today at a50 percent discount. Their inventory is valued at $400 and could be sold to acompetitor for that amount. The firm has $50 in cash and customers owe them $300.What is the accounting value of their liquid assets?a. $50b. $350c. $700d. $750e. $1,000BOOK VALUEc 54. Martha’s Enterprises spent $2,400 to purchase equipment three years ago. Thisequipment is currently valued at $1,800 on today’s balance sheet but could actually besold for $2,000. Net working capital is $200 and long-term debt is $800. What is thebook value of shareholders’ equity?a.$200b.$800c.$1,200d.$1,400e. The answer cannot be determined from the information provided.NET INCOMEb 55. Art’s Boutique has sales of $640,000 an d costs of $480,000. Interest expense is$40,000 and depreciation is $60,000. The tax rate is 34%. What is the net income?a. $20,400b. $39,600c. $50,400d. $79,600e. $99,600MARGINAL TAX RATEc 56. Given the tax rates as shown, what is the average tax rate for a firm with taxableincome of $126,500?Taxable Income Tax Rate$ 0 - 50,000 15%50,001 - 75,000 25%75,001 - 100,000 34%100,001 - 335,000 39%a.21.38 percentb.23.88 percentc.25.76 percentd.34.64 percente. 39.00 percentTAXESd 57. The tax rates are as shown. Your firm currently has taxable income of $79,400. Howmuch additional tax will you owe if you increase your taxable income by $21,000?Taxable Income Tax Rate$ 0 - 50,000 15%50,001 - 75,000 25%75,001 - 100,000 34%100,001 - 335,000 39%a.$7,004b.$7,014c.$7,140d.$7,160e.$7,174OPERATING CASH FLOWd 58. Your firm has net income of $198 on total sales of $1,200. Costs are $715 anddepreciation is $145. The tax rate is 34 percent. The firm does not have interestexpenses. What is the operating cash flow?a.$93b.$241c.$340d.$383e. $485NET CAPITAL SPENDINGc. 59. Teddy’s Pillows has beginning net fixed assets of $480 and ending net fixed assets of$530. Assets valued at $300 were sold during the year. Depreciation was $40. What isthe amount of capital spending?a.$10b.$50c.$90d.$260e.$390CHANGE IN NET WORKING CAPITALb 60. At the beginning of the year, a firm has current assets of $380 and current liabilities of$210. At the end of the year, the current assets are $410 and the current liabilities are$250. What is the change in net working capital?a.-$30b.-$10c.$0d.$10e. $30CASH FLOW TO CREDITORSe 61. At the beginning of the year, long-term debt of a firm is $280 and total debt is $340. Atthe end of the year, long-term debt is $260 and total debt is $350. The interest paid is$30. What is the amount of the cash flow to creditors?a.-$50b.-$20c.$20d.$30e. $50CASH FLOW TO CREDITORSa 62. Pete’s Boats has beginning long-term debt of $180 and ending long-term debt of $210.The beginning and ending total debt balances are $340 and $360, respectively. Theinterest paid is $20. What is the amount of the cash flow to creditors?a.-$10b.$0c.$10d.$40e. $50CASH FLOW TO STOCKHOLDERSa 63. Peggy Grey’s Cookies has net income of $360. The firm pays out 40 percent of the netincome to its shareholders as dividends. During the year, the company sold $80 worthof common stock. What is the cash flow to stockholders?a.$64b.$136c.$144d.$224e. $296CASH FLOW TO STOCKHOLDERSa 64. Thompson’s Jet Skis has operating cash flow of $218. Depreciation is $45 and interestpaid is $35. A net total of $69 was paid on long-term debt. The firm spent $180 onfixed assets and increased net working capital by $38. What is the amount of the cashflow to stockholders?a.-$104b.-$28c.$28d.$114e. $142The following balance sheet and income statement should be used for questions #65 through #71:Nabors, Inc.2005 Income Statement($ in millions)Net sales $9,610Less: Cost of goods sold 6,310Less: Depreciation 1,370Earnings before interest and taxes 1,930Less: Interest paid 630Taxable Income $1,300Less: Taxes 455Net income $ 845Nabors, Inc.2004 and 2005 Balance Sheets($ in millions)2004 2005 2004 2005 Cash $ 310 $ 405 Accounts payable $ 2,720 $ 2,570 Accounts rec. 2,640 3,055 Notes payable 100 0 Inventory 3,275 3,850 Total $ 2,820 $ 2,570 Total $ 6,225 $ 7,310 Long-term debt 7,875 8,100 Net fixed assets 10,960 10,670 Common stock 5,000 5,250Retained earnings 1,490 2,060 Total assets $17,185 $17,980 Total liab.& equity $17,185 $17,980 CHANGE IN NET WORKING CAPITALc 65. What is the change in the net working capital from 2004 to 2005?a.$1,235b.$1,035c.$1,335d.$3,405e.$4,740NONCASH EXPENSESd 66. What is the amount of the non-cash expenses for 2005?a.$570b.$630c.$845d.$1,370e. $2,000NET CAPITAL SPENDINGc 67. What is the amount of the net capital spending for 2005?a.-$290b.$795c.$1,080d.$1,660e.$2,165OPERATING CASH FLOWd 68. What is the operating cash flow for 2005?a.$845b.$1,930c.$2,215d.$2,845e.$3,060CASH FLOW OF THE FIRMa 69. What is the cash flow of the firm for 2005?a.$430b.$485c.$1,340d.$2,590e.$3,100NET NEW BORROWINGe 70. What is the amount of net new borrowing for 2005?a.-$225b.-$25c.$0d.$25e.$225CASH FLOW TO CREDITORSd 71. What is the cash flow to creditors for 2005?a.-$405b.-$225c.$225d.$405e.$630The following information should be used for questions #72 through #79:Knickerdoodles, Inc.2004 2005Sales $ 740 $ 785COGS 430 460Interest 33 35Dividends 16 17Depreciation 250 210Cash 70 75Accounts receivables 563 502Current liabilities 390 405Inventory 662 640Long-term debt 340 410Net fixed assets 1,680 1,413Common stock 700 235Tax rate 35% 35%NET WORKING CAPITALd 72. What is the net working capital for 2005?a.$345b.$405c.$805d.$812e.$1,005CHANGE IN NET WORKING CAPITALa 73. What is the change in net working capital from 2004 to 2005?a.-$93b.-$7c.$7d.$85e.$97NET CAPITAL SPENDINGb 74. What is net capital spending for 2005?a.-$250b.-$57c.$0d.$57e.$477OPERATING CASH FLOWb 75. What is the operating cash flow for 2005?a.$143b.$297c.$325d.$353e.$367CASH FLOW OF THE FIRMd 76. What is the cash flow of the firm for 2005?a.$50b.$247c.$297d.$447e.$517NET NEW BORROWINGd 77. What is net new borrowing for 2005?a.-$70b.-$35c.$35d.$70e.$105CASH FLOW TO CREDITORSb 78. What is the cash flow to creditors for 2005?a.-$170b.-$35c.$135d.$170e.$205CASH FLOW TO STOCKHOLDERSd 79. What is the cash flow to stockholders for 2005?a.$408b.$417c.$452d.$482e.$503The following information should be used for questions #80 through #82:2005Cost of goods sold $3,210Interest $215Dividends $160Depreciation $375Change in retained earnings $360Tax rate 35%TAXABLE INCOMEe 80. What is the taxable income for 2005?a.$360b.$520c.$640d.$780e.$800OPERATING CASH FLOWd 81. What is the operating cash flow for 2005?a.$520b.$800c.$1,015d.$1,110e.$1,390SALESc 82. What are the sales for 2005?a.$4,225b.$4,385c.$4,600d.$4,815e. $5,000NET INCOMEb 83. Calculate net income based on the following information. Sales are $250; Cost ofgoods sold is $160; Depreciation expense is $35; Interest paid is $20; and the tax rateis 34%.a. $11.90b. $23.10c. $35.00d. $36.30e. $46.20IV. ESSAYSLIQUID ASSETS84. What is a liquid asset and why is it necessary for a firm to maintain a reasonable level ofliquid assets?Liquid assets are those that can be sold quickly with little or no loss in value. A firm that has sufficient liquidity will be less likely to experience financial distress.OPERATING CASH FLOW85. Why is interest expense excluded from the operating cash flow calculation?Operating cash flow is designed to represent the cash flow a firm generates from its day-to-day operating activities. Interest expense arises out of a financing choice and thus should be considered as a cash flow to creditors.CASH FLOW AND ACCOUNTING STATEMENTS86. Explain why the income statement is not a good representation of cash flow.Most income statements contain some noncash items, so these must be accounted for when calculating cash flows. More importantly, however, since GAAP is used to create income statements, revenues and expenses are booked when they accrue, not when their corresponding cash flows occur.BOOK VALUE AND MARKET VALUE87. Discuss the difference between book values and market values on the balance sheet andexplain which is more important to the financial manager and why.The accounts on the balance sheet are generally carried at historical cost, not market values.Although the book value of current assets and current liabilities may closely approximate market values, the same cannot be said for the rest of the balance sheet accounts. Ultimately, the financ ial manager should focus on the firm’s stock price, which is a market value measure. Hence, market values are more meaningful than book values.ADDITION TO RETAINED EARNINGS88. Note that in all of our cash flow computations to determine cash flow of the firm, we neverinclude the addition to retained earnings. Why not? Is this an oversight?The addition to retained earnings is not a cash flow. It is simply an accounting entry that reconciles the balance sheet. Any additions to retained earnings will show up as cash flow changes in other balance sheet accounts.DEPRECIATION AND CASH FLOW89. Note that we added depreciation back to operating cash flow and to additions to fixed assets.Why add it back twice? Isn’t this double-counting?In both cases, depreciation is added back because it was previously subtracted when obtaining ending balances of net income and fixed assets. Also, since depreciation is a noncash expense, we need to add it back in both instances, so there is no double counting. TAX LIABILITIES AND CASH FLOW90. Sometimes when businesses are critically delinquent on their tax liabilities, the tax authoritycomes in and literally seizes the business by chasing all of the employees out of the building and changing the locks. What does this tell you about the importance of taxes relative to our discussion of cash flow? Why might a business owner want to avoid such an occurrence?Taxes must be paid in cash, and in this case, they are one of the most important components of cash flow. The reputation of a business can undergo irreparable harm if word gets out that the tax authorities have confiscated the business, even if only for a couple of hours until the business owner can come up with the money to clear up the tax problem. The bottom line。